This invention relates generally to financial instruments. More particularly, this invention relates to a method and computer-implemented process for creating lease backed financial instrument derivatives yielding higher than market returns.
Investment vehicles such as venture capital funds have certain risks. Venture Capital generally refers to the business of financing new business undertakings, usually high risk, in the hopes of reaping large rewards if the new business is successful. In a typical scenario, an inventor or group with a new idea will ask a venture capital fund to give them money to start a business built around the new idea. The financial return of the venture capital fund may be large, or in many cases the investment can be a total loss.
Due to the high-risk high-reward nature of such investments, the amount of investment capital available to fund such investments is very limited as investors are concerned about losing their investment. This new methodology is directed at solving the problem so investors can put their principal into higher risk investments like venture capital but know that their principal investment has been secured. This method, would minimize the risk of losses in failed businesses, and would permit investors to continue to finance worthy enterprises without concern about the security of their original principal.
As an example, consider a typical Venture Capital fund with a 10 year life that has raised $100 million to invest in start-up companies. Out of this funds, 2.5% per year for 10 years or $25 million goes for management fees and is not invested, and another 10% is then set aside for reserves, leaving 65% or $65 million that is actually invested in start-up companies. If this $65 million is invested over 5 years, it results in $13 million or 13% per year of the starting capital being invested over 5 years. Now, if the fund does well and averages 5 times return on invested capital, the $100 million fund can generate a 10 year return of $13 million×5 years×5 times=$325 million. However, if the fund does badly as in the case of several funds that invested in Internet start-ups, the investors can lose the entire $100 million resulting in a 100% loss.
With the secured fund methodology according to the present invention we take a different approach. From the $100 million in the fund, 10% also goes into a reserve but the balance $90 million is first invested into equipment leases yielding 15% per year or $13.5 million/year. From this, $2.5 million/year is again paid as management fees and the balance of $11.0 million/year is invested over 10 years. Now, if the fund does well and generates the same five times return on invested capital as the conventional Venture Capital fund, the cash flow invested would generate a return of $11 million×10 years×5 times=$550 million. In addition, in the 10th year, the investors get back their investment of $100 million as the leases mature regardless of the performance of the invested cash flow.
So in the first case if the fund does well, with the same $100 million invested in a Venture Capital fund, with the conventional fund the investors would receive back $325 million versus $650 million for the secured fund according to the present invention. This is double the cash return that the conventional fund offers.
However, if the fund does badly and all the investments are lost, in the worst case the conventional fund investors get back nothing. However, with the secured fund model, the investors still get their principal back as the leases mature in the 10th year.
This is why this new two-tier investment structure according to the present invention is so attractive. It essentially enables investors to get high returns in capital investments without the high risk associated with conventional investments available today.
Even if an investor puts money in an investment vehicle such as private equity fund, stock mutual fund or an individual stock, the investor runs the risk of loss of principal since the principal is not secured. If the fund goes down in value, the investor loses money and can lose the entire principal. As a result many investors have suffered huge losses in mutual funds and stock investments in the recent fall of the NASDAQ from over 5,000 to under 1,600.
The present invention is directed at solving the problem of securing the investors capital so that an investor can make money when the stock goes up and secures the return of principal if the stock goes down. An investor in a secured mutual fund using this two tier approach receives their principal back even if the NASDAQ drops in price because their principal is not at risk.
Furthermore, investors are finding that yields on safe fixed income investments are very low. Bank CD's are yielding 2-3% per year. investment grade bonds are yielding 2-16% per year and US government Treasuries are yielding 2-5% per year.
This invention is further directed at solving the problem of allowing investors to obtain yields that are 15% per year or higher and secured by investment grade collateral.
Many start-up businesses have received millions of dollars of investor capital that has been spent on starting the business with no revenue coming in. This appears as a net operating loss on the balance sheet of the company but has little value to the start-up until it becomes profitable.
The present invention is further directed at solving the problem of being able to use these losses as an asset by the start-up company.
In theory the concept of a two-tier investment structure is not new. An investor can take-their money, put it into corporate bonds with a 10-year life, get a 5% return and invest the interest earned in venture capital or stocks. The problem is that this conventional return on capital on A, AA or AAA rated corporate bonds is still around 3-5% giving little cash returns for investment as a two-tier structure. Hence, the two-tier structure cannot work in today's environment due to the low returns. Yet if the investor tries to get higher returns and puts the capital directly into venture capital or stock as is being done at present, there is the risk of loss of capital. In fact, investors have lost billions of dollars seeking high returns while the NASDAQ has fallen from over 5,000 to under 1,600 today. Using the methodology proposed here could have saved these companies billions of dollars.
The reason that no one has used equipment leases before, as part of a two-tier investment structure, is because of problems in finding high yielding value in the marketplace. Furthermore, there is no NASDAQ type exchange for equipment leases as there is for stocks or bonds, due to the lack of uniform evaluation methodology and exchange type mechanism to trade equipment leases. New equipment leases typically yield only 4% to 8% per year rates of return. The average length of a lease is typically 1 to 50 years depending upon the type of equipment from cars through railcars, aircraft and barges. Hence, using equipment leases does not seem to be an obvious solution to this problem.
It does become a solution when one analyzes equipment leases in great detail and break them up into their derivative elements. The opportunity is created when one becomes aware that the fair market value of the leased equipment decreases over time at different rates depending upon the type of equipment but the lease payments typically remain fixed or decline at different intervals over the length of the lease. As a result, if these residual leases, which may be several years old, are purchased in the secondary market and held for a predetermined optimum time period taking the lease payments, fair market values at the time of purchase and sale and other related facts into consideration, then it is possible to use these residual leases to create lease derivatives to obtain cash flows yielding 15% per year or higher.
Furthermore, the mathematical models being used can be applied uniformly through numerous categories of leases and the evaluation criteria and formulas used to establish rates of return for evaluating leases can also be used as the fundamental mechanism for a NASDAQ type trading exchange in which buyers and sellers can trade equipment leases.
Due to the complexity of evaluating hundreds and thousands of leases to determine specific leases to be bought and sold, establishing buying and selling parameters, and then using these derivatives to construct a portfolio, we have proposed our new algorithm and methodology to be computer implemented.